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THE CIRCULAR FLOW OF INCOME, EXPENDITURE AND OUTPUT (SLIDES 8-27) INTRODUCTION AND OVERVIEW DEFINITIONS MACROECONOMICS: THE STUDY OF THE AGGREGATE (TOTAL) BEHAVIOUR OF THE WHOLE ECONOMY.
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Macroeconomics
MICROECONOMICS: WE COVERED LAST TERM THAT IT IS THE STUDY OF THE ECONOMIC BEHAVIOUR OF INDIVIDUAL AGENTS, INTERACTING IN MARKETS. MACROECONOMIC AGGREGATES GDP: MONEY VALUE OF ALL FINAL GOODS AND SERVICES PRODUCED WITHIN A COUNTRY IN A GIVEN YEAR; OUTPUT. UNEMPLOYMENT RATE: % OF PEOPLE IN THE LABOUR FORCE NOT WORKING BUT SEARCHING FOR WORK. INFLATION RATE: % RISE IN THE AVERAGE PRICE OF ALL GOODS AND SERVICES. SAVING AND INVESTMENT RATES: WHAT IS 2 THE MEANING AND IMPLICATIONS
Balance of Payments
BALANCE OF (INTERNATIONAL) PAYMENTS: MONEY VALUE OF INDIAN GOODS, SERVICES AND ASSETS PURCHASED BY THE REST OF THE WORLD... MINUS THE MONEY VALUE OF FOREIGN GOODS, SERVICES AND ASSETS PURCHASED BY THE INDIANS. EXCHANGE RATE: INDIAN RUPEE PRICE OF A UNIT OF FOREIGN CURRENCY. OVERVIEW OF THE COURSE 1. EXPLAIN THE TIME-SERIES BEHAVIOUR OF THE MACROECONOMIC AGGREGATES: OUTPUT,INFLATION,UNEMPLOYMENT, EXCHANGE RATE, BOPs
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Overview
UNDERSTAND THE ROLE AND EFFECT OF POLICY: I. FISCAL POLICY: USE OF GOVERNMENT SPENDING AND TAXATION CHANGES TO AFFECT THE AGGREGATE ECONOMY. I.E., THE EFFECT OF BUDGET (DEFICIT) CHANGES ON THE ECONOMY AND, THE EFFECTS OF THE ECONOMY ON THE DEFICIT! ESPECIALLY: WHAT IS A BUDGET DEFICIT? WHAT IS THE NATIONAL DEBT? WHEN ARE THESE A 5 PROBLEM?
II. MONETARY POLICY: USE OF CHANGES IN THE MONEY STOCK OR THE INTEREST RATE TO AFFECT THE AGGREGATE ECONOMY. MONEY VERSUS INCOME. RESERVE BANK OF INDIA AND ITS ROLE IN DETERMINING THE MONEY STOCK. GOALS OF THE RBI: FULL EMPLOYMENT? PRICE STABILITY? WHAT IS THE BEST RATE OF INLATION? WHAT IS THE "NON-ACCELERATING INFLATION RATE OF UNEMPLOYMENT? 9%? (WHETHER INDEPENDENT/ IMPOSED OBJECTIVES WILL BE DISCUSSED UNDER MONETARY POLICY IN INDIA) III. PHYSICAL CONTOLS: CONTROLS LIKE INVESTMENTS, PRODUCTION/ DISTRIBUTION, 6
POLICY
POLICY DILEMMAS
WHAT ARE THE COSTS AND BENEFITS OF REDUCING THE RATE OF INFLATION (TO ZERO)? FUNDAMENTAL ISSUES: IS THE PRIVATE ECONOMY STABLE? CAN THE FISCAL OR MONETARY AUTHORITIES AFFECT THE MACROECONOMY? SHOULD THE FISCAL OR MONETARY AUTHORITIES TRY TO AFFECT THE MACROECONOMY?
SIMPLE ECONOMY
FIRMS EMPLOY ALL THE FACTORS AND PRODUCE ALL THE GOODS AND SERVICES (OUTPUT) THE FLOW OF OUTPUT FROM FIRMS TO HHs IS MATCHED BY THE FLOW OF EXPENDITURES FROM HHs TO FIRMS. ALL EXPENDITURE = VALUE OF ALL OUTPUT THE FLOW OF FACTOR SERVICES FROM HHs TO FIRMS IS MATCHED BY THE FLOW OF FACTOR PAYMENTS (INCOME) FROM FIRMS TO HHs. ALL INCOME = ALL EXPENDITURE
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FIRMS (suppliers of goods and services, demanders of factor services) HOUSEHOLDS (demanders of goods and services, suppliers of factor services)
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FLOWS VS STOCKS
A FLOW OCCURS CONTINUOUSLY THROUGH TIME, MEASURED IN UNITS PER TIME PERIOD. A STOCK IS AN ACCUMULATED QUANTITY, EXISTING AT A MOMENT IN TIME, MEASURED IN SIMPLE UNITS. E.G.: QUANTITY OF WATER IN A LAKE TODAY? A STOCK. QUANTITY OF WATER PASSING THROUGH A RIVER'S MOUTH PER SECOND? A FLOW. INCOME PER YEAR? A FLOW MONEY IN YOUR WALLET AND BANK ACCOUNT AS ON JAN 01, 2012?A STOCK
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RELATIONSHIPS
NEW CAPITAL GOODS PRODUCED THIS YEAR? A FLOW CAPITAL STOCK ON DEC. 31, 2011? IN OUR SIMPLE ECONOMY, ALL INCOME (Y) IS CONSUMED (C) (SPENT ON CONSUMPTION GOODS AND SERVICES) Y=C AGGREGATE EXPENDITURE (AE) = C AND THE VALUE OF ALL OUTPUT EQUALS AE Y=C SO EXPENDITURE = OUTPUT = INCOME
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EXAMPLE
WEALTH= ASSETS-LIABILITIES THESE ARE ALL STOCKS. E.G. YOU HAVE A HOUSE WORTH RS 200,000 FINANCED BY A MORTGAGE (BANK LOAN) FOR RS 150,000. YOUR EQUITY (WEALTH) ON JAN. 12 IS RS 50,000.
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INVESTMENTS
BUSINESS FIRMS CAN SELL SOME OUTPUT (CAPITAL GOODS) TO OTHER FIRMS, OR ADD IT TO THEIR STOCKS OF INVENTORIES. (FIXED) INVESTMENT: PURCHASES BY FIRMS OF NEWLY PRODUCED CAPITAL GOODS (MACHINERY, EQUIPMENT AND STRUCTURES) INVENTORY INVESTMENT: CHANGES IN THE STOCK OF FINISHED GOODS AND RAW MATERIALS HELD BY FIRMS. FIRMS FINANCE THIS INVESTMENT BY BORROWING FROM THE FINANCIAL SECTOR
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INVENTORY
THIS IS IDENTICALLY TRUE BECAUSE ANY OUTPUT WHICH IS NOT SOLD TO FINAL CONSUMERS OR AS FIXED INVESTMENT IS ADDED TO INVENTORIES. THIS INVENTORY INVESTMENT IS INCLUDED IN OUR DEFINITION OF INVESTMENT. IF CONSUMPTION PLUS FIXED INVESTMENT EXCEEDS THE VALUE OF CURRENT OUTPUT, THE FIRMS SATISFY THE EXCESS BY SELLING PREVIOUSLY PRODUCED GOODS OUT OF THEIR INVENTORIES. THIS NEGATIVE INVENTORY INVESTMENT IS INCLUDED IN OUR DEFINITION OF INVESTMENT 17
Rs.
Factor services
Rs.
Goods P P2 P1 D2 D1
P PF2 PF1
D2 D1 O Goods Q1 Q2 Q
QF1 QF2
Factor services
Rs.
Rs.
AGGREGATE EXPENDITURE ON INDIAN OUTPUT: AE = C + I + (X - M ) AND, AS BEFORE, ALL DISPOSABLE INCOME IS EITHER CONSUMED OR SAVED: Y=C+S ADD THE GOVERNMENT SECTOR GOVERNMENT CAN PURCHASE OUTPUT = G, AN INJECTION GOVERNMENT CAN SUBTRACT TAXES (TA) FROM INCOMES AND ADD TRANSFERS (TR) TO INCOMES
AGGREGATE EXPENDITURE
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Expenditurecontd
DISPOSABLE (TAKE-HOME) INCOME (YD) IS INCOME (Y) MINUS TAXES PLUS TRANSFERS T = TAXES (TA) MINUS TRANSFERS (TR) YD = Y - T T, NET TAXES, IS A LEAKAGE NOW, AGGREGATE EXPENDITURE AE= C + I + G + (X -M) = OUTPUT = Y = INCOME =C+S+T BECAUSE YD = Y - T AND YD = C + S
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INJECTIONS Export Export expenditure (X) expenditure (X) Investment (II ) Investment ( ) Consumption of domestically produced goods and services (Cd) Government Government expenditure (G) expenditure (G) BANKS, etc GOV. ABROAD
Factor payments
WITHDRAWALS
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SUMMARY
EXPENDITURE=OUTPUT=INCOME INJECTIONS = I + G + X LEAKAGES = S + T + IM IF I INCLUDES ONLY PLANNED INVESTMENT SPENDING (IP), EQUILIBRIUM OCCURS WHEN INJECTIONS EQUAL LEAKAGES IP + G + X = S + T + M IF I INCLUDES UNPLANNED CHANGES IN INVENTORIES (FORCED ACCUMULATIONS TO/RUNDOWNS FROM EXISTING STOCKS), ALL EXPENDITURE = INCOME IS AN IDENTITY: Y= C + I + G + (X - M)
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SUMMARYcontd
AND: Y = YD + T = C + S + T SO, SUBTRACTING C: I + G + X -M = S + T FUNDAMENTAL MACRO IDENTITY I+G+X=S+T+M REARRANGING: (G - T) + I = S + (M - X) GOV'T BUDGET DEFICIT PLUS PRIVATE INVESTMENT EQUALS PRIVATE SAVINGS PLUS "LOANS" FROM THE ROW.
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LEARNING
1. 2. 3. 4. 5. 6. HOW TO STUDY ECONOMIC TRANSACTIONS BETWEEN SECTORS OF A COUNTRY IN THE FORM OF CIRCULAR FLOW DIFFERENCE BETWEEN FLOWS AND STOCKS SOME POLICY DILEMMAS OPEN AND CLOSED ECONOMIES INJECTIONS AND LEAKAGES MACROECONOMIC IDENTITY DOES THE TOPIC MAKES BUSINESS SENSE? OF COURSE YES. SINCE FORCED INVENTORIES (RUNDOWN AND BUILING UP) IS WHAT THE BUSINESS MUST BE WANTING TO PREVENT. IF THE MACRO LINKAGES ARE WELL UNDERSTOOD, IT CAN HELP IN A GREAT MANNER TO FORECAST WHAT WILL BE THE 27 IMPACT ON INVENTORIES AND CORRESPONDING